6-minute read
For companies that engage in research and development (R&D) spending, there are valuable tax credits that can be taken. But all too often small business owners and those who are creating startups don't realize these R&D credits exist. A tax advisor might catch them, but many small businesses handle their own taxes.
Even a good tax advisor also doesn't know all the details of your business, and you might not be sure what kind of business activities qualify as R&D, either. Here's what you need to know about these valuable credits, so you don't miss out.
What Are R&D Credits?
Small businesses that perform research and development activities may be eligible for non-refundable R&D credits on their taxes. But there are only certain types of activities that qualify for the credits. Knowing that in advance could shape how your business handles its research and development, so it could adjust its efforts in ways that legally allow it to take the credits.
The dollar-for-dollar reduction in current tax liability that comes from these credits could mean more money for your small business to spend. If you have a startup operation that could be especially important since many startups are working on a shoestring budget until they have more cash flow coming in and get more established.
The credits can also be carried back one year and forward 20 years, so if you don't use all the credit in the current year you will not lose out on the value of it. If qualifying activities were performed in previous years and you have documentation for that, you can also file an amended tax return going back up to three years. That could give you the credit for those three years, even if you didn't have it on your original return.
What Qualifies for R&D Credits?
Not all research and development activities undertaken by a small business qualify for the tax credit, but many of them do. The key is to know which activities qualify, so you can focus on those particular options moving forward. That can mean more opportunity to get the credit and can add to the cash flow of your business in a way that is immediate and convenient.
Activities that are considered valid for qualified research expenditures include things like the development or improvement of a product or the development of new technology. Both of these areas are vital when it comes to the advancement of society, so they have to be undertaken by companies that want to keep their products on the market and remain relevant.
These activities can also bring valuable items to store shelves or even revolutionize the way people communicate or the types of treatments they receive for a medical condition. Because there are so many ways to create or improve a product, most of those ways fall under the expenditures for qualified research. Just make sure there is plenty of documentation, in order to reduce the chances that the credit would be denied for a misunderstanding or another reason.
The creation of a new (or improved) production process also counts when it comes to obtaining R&D credits for a small business or startup. The development of something important isn't limited to a product. It can also have to do with how that product is created or produced. A production process that's faster, easier or less expensive could revolutionize an entire industry. That's well worth the ability to get credits that can encourage this kind of research and development.
Software and model prototypes are other areas where R&D credits are often available. A small business that comes up with new software or a startup that creates a prototype for something unique and valuable can claim these credits on their taxes and see their tax liability reduced. In some cases, the liability will be reduced by a significant amount based on the cost of the research and development that took place.
How Much Are the Credits Worth?
The credit is calculated as a percentage of the company's R&D expenses. There is a base amount, and then the credit can be for as much as 20 percent of the excess as long as it is used for qualified research. There is no evidence that the audit risk rises by claiming these types of credits, and there are a lot of specific items that can be included in the expenses.
For example, materials, wages, and payments to third-party vendors are often tax write-offs, but they can also be used as part of the R&D credit if they were for research and development in any way. These expenses will lower taxable income as part of the way most companies handle their taxes, and then the same expenses can help that company again as part of the research and development credits.
This is a major tax break that most companies aren't taking advantage of, but your company doesn't have to miss out on this valuable opportunity.